The poverty of rationality

Steve Williamson has written a much longer critique of Zombie Economics. It’s a lot more temperate in tone than the blog post I criticised here, and there are some valid points. Nevertheless, the new version exhibits the same fundamental confusion I pointed out last time, trying to claim that rationality assumptions are both important and unfalsifiable.

I’m criticising it again because, in making this mistake, Williamson is not exactly Robinson Crusoe[1]. The same confusion is evident among a great many economists, and even more among proponents of rational choice models in political science and other social sciences. This, despite the fact that the key error was skewered by William Hazlitt nearly two centuries ago, writing on self-love and benevolence.

Before starting, I’ll make a brief, purely mathematical point. Any consistent pattern of choice among objects (of any kind) that we can observe, can be represented as optimization, that is, as the maximization of a function. The classic version of this result was proved by Cantor, who gave us the modern idea of a function as a mapping between sets, and cleared up a lot of the technical puzzles about continuity and so on. Even choices that are inconsistent in various ways can be represented by more general notions of optimization. So, it makes no sense either to claim (as a lot of economists do) that the fact that we can represent action as the maximization of some “objective” function proves anything positive about the way people think or to object (as a lot of non-economists do) to representing choices in terms of optimization. To (ab)use an apposite quote – this isn’t class warfare, it’s math.

Williamson invokes the Cantor result in support of rationality assumptions saying

If the phenomenon can be described, and we can find some regularity in it, then it can also be described as the outcome of rational behavior. Behavior looks random only when one does not have a theory to make sense of it, and explaining it as the result of rational behavior is literally what we mean by “making sense of what we are seeing.

and in response to my criticisms, that I offer

”“ the usual list of complaints, for which there are standard defenses. (i) We can observe economic agents behaving irrationally, so what is all this rational agent stuff about? Answer: If you think you are observing irrational behavior, you just have the wrong model. Think harder.

So far, our disagreement is essentially semantic. Williamson wants to use the term ‘rational’ to describe optimization with respect to any function whatsover. In this includes the kind of behavior displayed by an agent (not necessarily an individual) in a model, any model. So, I can present whatever model I like, and the behavior in it is necessarily rational, and any rational behavior involves optimising something or other. Provided my model exhibits some regularity in the behavior of agents, they must be optimising something – working out what is the kind of problem normally given to sharp grad students.

By contrast, I normally use‘rational’ to refer to the kind of behavior found in the simplest form of the DSGE models: farsighted, and purely egoistic, agents maximizing the expected utility of stochastic consumption streams over time. Most of the time, at least when no-one is challenging them on it, this is the way neoclassical economists use the term themselves.

And this applies to Williamson himself. At the beginning of his defense of modern macro he writes “A second key principle in the post-1970 macroeconomic research program is adherence to optimization – a key organizing principle in all of economics.”

But we’ve already seen that, according to Williamson, any possible behavior involves optimization. That includes the behavior described by Keynesian macro models, not to mention Marxist, institutionalist and even Freudian models. So, this “key principle” is, on Williamson’s account, entirely devoid of content.
In reality of course, Williamson wants to have his cake and eat it. Most of the time he wants to help himself to the strong implications of rationality as represented in standard micro texts, and to demand that macro be built on this basis. But, when this model is challenged on empirical grounds, he retreats to a concept of rationality that is tautologically true. This is a classic example of John H’s “two-step of terrific triviality”.

To quote my own favorite bon mot on this

most rational actor models assume that “rationality” can be represented as “maximization of self-interest”. This assumption is either false or vacuous. Those committed to egoistic rationality tend, when challenged, to oscillate between the two definitions, in much the manner of the function sin (1/x) as x approaches zero.’

The one appeal to empirical evidence in his entire defence of modern macro is, unsurprisingly, the observation that the Keynesian models of the 1960s ran into big problems and that, at least arguably, this reflected the fact that they failed to take adequate account of the way in which workers and firms would rationally respond to higher inflation. Of course, I described that process in Zombie Economics and went on to show how the demand for rational microfoundations led to DSGE macro which failed in its turn. It’s in responding to this failure that Williamson relies on the non-falsifiability of his preferred group of models.

More on similar lines from Noah Smith

fn1. Our profession’s favorite representative individual

90 thoughts on “The poverty of rationality

  1. TerjeP Sure moving can be a good thing if there is enough support for the family. The problem is that with your philosophy toward the poor and less able, why would your minimal safety net government bother with policies to provide them with this support?

  2. TerjeP Whatever, I’m not precious, I’m taking my medication and working on my self-development and I’ll be right mate.

    Much potential for misunderstanding between a rational man and an irrational woman, though.

  3. Julie – by force I generally mean make somebody do something via the application of physical force or the threat of physical force. Obviously I was simplifying a little because we are not forced to vote. We are compelled to mark our name of at the polling both with the threat of a fine. If we refuse to pay the fine we may be forced to spend time in a cage. So the force is not applied directly to make us vote however it is still very real. Certainly we are told in government advertising that voting is compulsory. So I think my short hand use of the term force was fair enough. And I’d like to know what you think of people being forced to make such a choice (ie to vote) when many clearly lack the capacity to make an informed or wise choice.

  4. … the modern idea of a function as a mapping between sets …

    You’re out of date. The modern idea of a function is a set of ordered pairs, e.g. {(0,0), 1,1), (2,4), (3,9), …} is the set describing the function of squares of non-negative integers.

    … We can observe economic agents behaving irrationally, so what is all this rational agent stuff about? Answer: If you think you are observing irrational behavior, you just have the wrong model. Think harder.

    This is not an adequate answer, because it omits the possibility that there may be no solutions in the accessible address space, e.g. thinking harder won’t find a rational square root of two, and (more to the point) some things are inherently uncomputable and/or undecidable. While it would not be a surprise if all the questions economics addresses turned out to have “rational” meanings (in this sense), neither would it be a surprise if some didn’t and if “looking harder” turned out to be no way to proceed. After all, it was also Cantor who first showed the way to just such things, with his method of diagonalisation.

    I would suggest you try diagonalising to see if you can find something of this sort that cannot be adequately represented as optimisation – you might well find that there was something. Even if it turned out to be overly artificial, the limits you found would indicate the limits of your subject area.

  5. PML – what if I define the following function:-

    f(x,y) = x + y

    It does not seem to be a set of ordered pairs. It seems to be a mapping from one set (cartesian plane) to another set (real number set).

  6. TerjeP, PML was talking about functions of a single variable. For functions dependent on n variables, define a set of ordered (n+1)-lets, as in
    {(x,y,…,z,f(x,y,…,z)) for all x, y,…,z in the domain}

  7. PML, I’m trying to make life easy for the readers here. The definition I gave was the one introduced by Cantor, and still the one that’s most commonly used. The ordered pair characterization is equivalent, and is a bit more “modern” in style, though the appeal of that kind of modernity peaked a few decades ago, I think.

    On your second point, economists spend a lot of time worrying about lexicographic orderings and similar, which create technical difficulties of the kind you describe. My own view is that the data set is always finite, so there is no real need for such worry.

  8. Terje, I agree with you when you say that any system will suffer from behavioural anomalies.

    However, departures from rationality is not just about poor decisions about spending money as you say.

    This paper shows the relevance of that behavioural stuff to a topic I’m sure that your fond of. By the way, 1930 cites on Google Scholar should indicate that I didn’t just pull it out of some institution that publishes material which may or may not confirm my default bias (IPA for some).

    Also, I reckon your link between mental health and welfare dependence is a huge call. I know that you based this on your own experiences but any peer-reviewed papers to support your claim is welcome.

  9. W – The paper is behind paywall. I’m not likely to buy it blind so if you want to enter it into the discussion how about your summary of what it says.

  10. @sam

    I’ve got a lot of time for PML but on this occasion he was being pedantic (as JQ makes plane). I was merely returning the favour. 😉

  11. Sorry Terje, I didn’t mean that, I am used to being logged in through the uni website.

    The endowment effect is summarized here

    Some quotes relevant to Coase theorem:

    “According to the Coase theorem, the allocation of resources to individuals
    who can bargain and transact at no cost should be independent of initial property rights. However, if the marginal rate of substitution between one good and another is affected by endowment, then the individual who is assigned the property right to a good will be more likely to retain it.”


    “The existence of endowment effects reduces the gains from trade.
    In comparison with a world in which preferences are independent of
    endowment, the existence of loss aversion produces an inertia in the
    economy because potential traders are more reluctant to trade than is
    conventionally assumed. This is not to say that Pareto-optimal trades
    will not take place. Rather, there are simply fewer mutually advantageous
    exchanges possible, and so the volume of trade is lower than it
    otherwise would be.”

    What I do not claim is that the government should wipe our brains of the endowment effect or that the government should intervene and la la slippery slope to the Soviets.

    What I do suggest is the endowment effect does call into question the efficacy of “Define the property rights, let Coase sort em out” approaches.

  12. from Wikkpedia on rationality:

    if one accepts a model in which benefiting the group is optimal, then purely selfish behavior is deemed irrational. It is thus meaningless to assert rationality without also specifying the background model assumptions describing how the problem is framed and formulated.

    Some people increase their decision making capacity by limiting the factors included in the frame for rational decision. By kicking out “a benefit to a group” or “hurting others” or “empathy” factor you get conservative/neoliberal rationality.

  13. @Dan

    Tax is fraught with such problems. A land tax and stamp duty can be argued but only with some specifics. In the ACT “land tax” is really a landlords tax payable if a investment property is rented. It is different in other jurisdictions. Whether a tax is progressive or regressive cannot be divined from the name of a tax. You need to know its structure.

    I do not see any point in abolishing stamp duty and replacing it with land tax (unspecified) – which some have suggested.

    Stamp duty is paid even if primary residences are sold (except when first home buyers concession applies). This means that abolishing stamp duty benefits the rich more than the poor because the rich have invested large amounts in mansions as primary residences and scoop up the capital gain.

    So it seems, abolishing stamp duty is a typical policy of right-wing elements.

  14. @Chris, #16

    Compensate if necessary, at least transitionally. A broad-based land tax is a more sensible, frictionless tax, and of course the majority of houses aren’t mansions; the majority of people aren’t rich.

    I should add that you won’t have a great deal of trouble convincing me that the income tax that the rich pay could be cranked up to net social benefit.

  15. Stamp duty is a tax on transactions and can act as a disincentive to trade. Land tax, like council rates, is a value tax and as such is more fair – thresholds can be applied.

  16. @W
    Or you can optimize it even more when faced with lack of money to feed, house and educate your family. It would be all good without externalities such as Great Recession, Which Julie points out how it can affect your decision making process being overwhelmed by choices. Increase of divorces during economic hardship is an example of increased optimizing (wrong decisions) forced by externality. Fairness diminish when faced with economic hardship.
    My point was that a person has a defined capacity for rationality and optimizing is enforced between different groups of life decisions. Different groups like making income and political preference, choice of friends etc.. Having to expand one group’s rationality forces the optimization of another less essential group.
    Increased optimization of less essential decisions, like political decisions, is forced upon population during persistent recessions. Increased optimization means more conservative rationality. Longer the recession/ depression persist bigger the chance that conservative will win the election. Up to a point and then switches to reactionary opposition. Isn’t it that how during the Great Depression you got two opposites: fascism and communism? Individualism and collectivism.

  17. A spam plug for cialis made it past the blocker. How did that happen? Admittedly, it was in Spanish, but I’m still surprised.

  18. Terje That explanation of ‘force’ is a poverty stricken definition and it allows you use the term in any way you want so as to win a point.

    For example, you will say that the workers weren’t forced by the mill owners to work in such lousy conditions but you are able to say that we are forced to vote. Does that not strike you as an inconsistent and a self-serving way of thinking?

    First, my view is that compulsory voting functions as one of those social mores that a lot of philosophers consider essential to a decent and stable society. Social mores, particularly ones that give us a reason to feel ‘equal’, psychologically bind us together as a society. Compulsory voting gives us something very significant to feel ‘together’ about, whether we are whinging about it or loving it.

    Secondly, as an irrational, irreverent and creative individual, I revel in finding ways to outwit the state when I consider it to be too bossy. I live right in conservative party heartland, so it doesn’t matter a hoot who I vote for. I had managed to avoid registering to vote until I was in my 40’s. Then I was ‘forced’ to register, by a very nice man at my door, who didn’t threaten me with the application of physical force; just a fine, he said.

    On my income, a fine is a significant threat but if I felt strongly enough about my right not to vote, I would pay the fine each year. I ignore the law on marijuana smoking also, and I note that I have seen mention of this illegal activity by known libertarians on Catallaxy, and you didn’t condem it there so don’t go all sanctimonious on me.

    But, because of my education, I was able to develop meta cognition and now I know that going out is good for me; to become less anxious, I now know that I need to constantly battle the tendency, so I conceptualise the task of getting out of the house and going to the polling place as a personal challenge and character building.

    Also, I am only ‘forced’ to go to the booth. I am free to be creative there by voting for Spinoza, if I want. I recommend Spinoza to you as a philosopher worth reading. He has some ideas on the state. His credibility for me, comes from the way he lived his life. He was not a hypocrite.

  19. Terje I read that, in your personal experience welfare was a negative factor in at least one case. The fact that my experience is different, surely suggests that you might look for the factors – psychological, social or chance, that mediate this difference rather than dismissing my positive experience as less significant than your negative experience.

    I totally agree that in some cases welfare without any concomitant obligation to society can and does have negative outcomes. Howard’s attempt to impose ‘mutual obligation’, was derided by the welfare class, not because they didn’t like the idea but because they didn’t trust a conservative to have their best interests at heart. That was the understanding I had at the time. The answer is not to do away with welfare but to use it as a tool to improve people’s ability to participate.

    I’ll give you an example of how lack of welfare leads to negative personal outcomes. I believe that if there had been welfare back in the 50’s and 60’s, my mother would have been able to be a stay at home mum and look after me and my brother and sister. Because my father was in and out of psychiatric hospitals for a number of years, before he did kill himself, my mother was the one who had to run the printing business, they had.

    She was not a good business person, unlike my father, who in his good periods – he was bi-polar – functioned pretty well. To feed and keep us, she worked really really long hours for very little profit and we were left to fend for ourselves for most of the day and up to 10 oclock at night, for years.

    My father was ok until I was about 8 or 9 when he went seriously downhill. So during the teenage years, there was no-one there for me, to help me to make good choices in the area of a career, and a suitable partner etc.

  20. @rog

    A stamp duty is a disincentive to some trade but creates a incentive to trade elsewhere, according to various signals from the community – queues in outpatients departments, waiting lists for housing etc. As funds are now available to meet this unsatisfied demand, the net increase in utility is positive.

    Land tax (in the ACT) is really a income tax, in that it falls only on the extra income a landlord obtains. There are also ACT ‘betterment’ taxes on rezoning. These both create the same disincentive to produce and rent out housing.

    All taxes that are conducive to thresholds, can be fair and equitable.

    So there seems no reason to prefer land tax to stamp duty. Just ensure the tax base is a broad as possible and thresholds are applied fairly.

    However, if we did not have such a huge need for the welfare and military state, it may be possible to eliminate all taxation other than a well structured progressive tax on economic profits.

  21. Terje That explanation of ‘force’ is a poverty stricken definition and it allows you use the term in any way you want so as to win a point.
    For example, you will say that the workers weren’t forced by the mill owners to work in such lousy conditions but you are able to say that we are forced to vote. Does that not strike you as an inconsistent and a self-serving way of thinking?

    There are other definitions for force. I’m just giving you the definition I intend when I discuss political philosophy.

    You support mandatory voting and have a justification for doing so. I support an increase in economic freedom. You lament economic freedom because it offers too much choice. May I suggest that your agenda is actually nothing more than soft socialism dressed up. The issue for you isn’t about people’s capacity to make choices but the economic system you prefer and the mode through which people make choices. You don’t mind people choosing laws and politicians but they can’t cope with what you see as the excessive choice of products at the supermarket.

  22. @Terje: “May I suggest that your agenda is actually nothing more than soft socialism dressed up.” If you mean social democracy, I think you’ll find that most people here, and most Australians, are social democrats of one stripe or another. On equity/ethical grounds and also because they see empirical evidence for social democracies as being more economically and socially resilient.

    “…but they can’t cope with what you see as the excessive choice of products at the supermarket.” No need to trivialise social democratic concerns. If that’s what you think most social democrats lose sleep over, you’ve failed terribly to understand the way economic power works and is exercised. Try reading Myrdal – he won the Nobel the same year as Hayek…

  23. @Julie Thomas

    There is no more force involved in compulsory elections than the inherent force involved in wearing clothes and road rules. Only capitalist tricksters associate this with the force involved in the social power of Capital. They do this to blur criticism.

    If the acts of parliament are applied compulsorily onto everyone (such as conscription), then the processes electing them need to be as representative as possible.

    Once a capitalist has Capital, and a regime of property rights, they can drive society into the ditch and force more and more people into penury – as they make themselves rich.

    While we should accept the force of having to choose based on our income, this is conditional on a prior requirement that everyone’s income truely reflects their productivity.

    Unfortunately this requirement does not exist – Capitalism is based on forced determination of wages (or in fact wage denial under Howard/Harper), but a pretended freedom thereafter.

    Getting logic out of capitalists is harder than extracting blood from stones.

  24. I am surprised nobody has mentioned the work of probable future Nobel Prize winner Richard Thaler here. My understanding is that he regards much of human behavior as irrational in the weak sense that one has to write very unusual utility functions (e.g. non-monotonicity, hyperbolic discounting, including social norms etc) to be able to describe it as optimization.

    Drug and alcohol abuse, obesity, drink driving, problem gambling, most crime, some poverty and plenty of other social ills probably fall into this category. If Thaler’s behavioral view is correct it forms a very powerful counterargument to the libertarian view sometimes expressed here.

    Thaler’s policy advice is that the best way to manage these ills is to allow people a choice, but try to ‘nudge’ them in the right direction. For example (as Sam mentioned) make people opt out for organ donation rather than opt in, or place the unhealthy food high up and away from easy reach at the supermarket.

  25. markets = fear and greed.

    rational behaviour does not get a look in.

    the logic of perpetual gain drives the process.

    and “bulldust baffles brains” = mode of operation.

    which leaves the simple minded well ahead.

    “buyer beware” .

    as in

    i’m not pleased to meet you.
    you have many names
    i’m not confused at all
    by the nature of your games.

  26. Having read Williamson’s screed, I was gobsmacked by someone who could claim, without apparently experiencing any cognitive dissonance, both that:
    “Quiggin thinks – and he would be correct – that most economists have the opinion that unions perform no useful economic role in modern society. While one could argue that unions played a crucial early role in the adoption of humane work practices and workplace safety, in most developed economies there is a well established structure of laws and enforcement that deals effectively with safety on the job, workplace harassment, and other issues. A good case can be made that unions act mainly to stifle competition, to inhibit innovation, and to slow technological advance” (page 18)
    and that:
    “The tools of modern finance and macroeconomics are not the instruments of conservative elements in society, serving only to bludgeon the working class. These in fact are the tools of science, and as such they can be used effectively by liberals and conservatives alike to make the world a better place.” (p23)

    Maybe he means Australian Liberals/Conservatives and missed a “for Liberal conservatives” at the end of the last sentence. If mounting a full-on case for the uselessness of unions and claiming that “laws and enforcement” to protect workers would somehow exist without any organised working class political/economic pressure is not intellectually “bludgeoning the working class” I’m not sure what is. He ought to take a look at the workplace death statistics under Howard/Abbott.

  27. In talking about rationality and various models of self-interest, most obstinate defenders, like our friend, Williamson, engage in bait and switch. The model they start off with does, typically, have refutable assumptions, but when someone points out that both the assumptions and the implications have been long refuted by evidence, they then quickly switch to the more metaphysical irrefutable and therefore immune and vacuous form. However, it is never that vacuous form that they use to attempt to navigate the world precisely because it says nothing about the world, which is why it is immune to refutation.
    The bon mot covers this rapid switching behaviour well. So basically they always operate with two models. The one they use, and the useless one they are willing to defend, when that first model is under attack.
    Entertaining as this behaviour might be, the first or even second time encountered, people like Williamson ought to make a choice. Do they want to be taken seriously as academics, or even as rational beings, or do they want to continue to behave more like a character one might more appropriately expect to find in a Lewis Carroll piece of literary nonsense?

  28. Freelander :Entertaining as this behaviour might be, the first or even second time encountered, people like Williamson ought to make a choice. Do they want to be taken seriously as academics, or even as rational beings, or do they want to continue to behave more like a character one might more appropriately expect to find in a Lewis Carroll piece of literary nonsense?

    I think they want us to believe that what they say three times is true.

  29. Economics is, in my opinion, like the law. It is what you make of it. You can produce all the lovely theorems and equations you like, you can produce, or fabricate all the statistics (damned statistics!) you desire, but it remains a poor pseudo-science, particularly when it pretends to exhibit ‘scientific rigour’. Economic theory depends far more on the economist’s ideology, personal preferences and psychology than on ‘science’. And how could it be otherwise? Even in physics our knowledge may have greatly increased, but so too has our ignorance. I prefer political economy, where the researcher’s ideology is front and centre and economic formulae and theorems are bedded in real life, real politics, real sociology and real human interaction. The quote above, that ‘..most economists have the opinion that unions serve no useful role..’ is not science, nor even pseudo-science. It is pure ideology, founded in psychology. You can see exactly why the Friedmanite catastrophe, that has caused such destruction and human suffering, was first applied at the point of a bayonet and through the murder of thousands of just such human beings, who, for the Right, had no ‘useful role’ but to fill disused mine shafts.

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